Global Bond Fire

The stock market rout continued on Monday as shares dropped sharply in markets around the world. China’s Hang Seng was particularly hard hit (down 449 pts) following reports on state media of a “moratorium on transfers, online banking, and counters.” The Bank of China’s aggressive steps to curtail nonbank “shadow” lending, has intensified a liquidity squeeze that’s now impacting normal banking activities. The unexpected cash crunch has intensified the fears of jittery investors who are still reeling from last weeks announcement by the Fed that it would reduce its long-term asset purchases as soon as the end of 2013. The FOMC’s statement put equities into a nosedive while bond yields on benchmark 10-year US Treasuries soared to their highest level in more than 2 years. The Fed–whose credibility has been badly damaged by its inability to hit its unemployment or inflation targets–now faces the prospect of sliding stock prices accompanied by rising long-term rates that will undercut the fragile economic recovery. This is from Bloomberg:

“U.S. stocks retreated, sending the Standard and Poor’s 500 Index to a nine-week low, as Chinese equities entered a bear market amid concern a cash crunch will hurt the world’s second-largest economy and speculation increased that the U.S. will begin curbing stimulus.

“Investors have been shaken by the concept of rising interest rates and a reduction in stimulus from the Federal Reserve, coupled with the uncertainty regarding effectively how robust the Chinese central banking system is,” Ethan Anderson, senior portfolio manager for Rehmann Financial in Grand Rapids, Michigan, said by phone.” (Bloomberg)

Markets have been bitch-slapped by rate shock and early fiat withdrawal symptoms. Four years of monetary pump-priming and unprecedented easing has reduced a cache of hardbitten Wall Street traders into a passel of whiny, liquidity-addicted basket cases who fall-to-pieces at the mere suggestion of an end to Bernanke’s massive monthly subsidy-handout.

The Fed’s announcement ended a long period of relative calm in the markets as extreme market volatility has returned with a vengeance. Rising yields and China woes have triggered a flight from interest-rate-sensitive emerging markets increasing the probability of a global slowdown. Investors pulled more than $3 billion out of EM stock funds last week alone. The Fed’s belief that economic data will steadily improve, has reversed flows which will be a damper on growth in the mainly raw materials-dependent countries.

The bond market has been walloped bigtime by the change in policy. Yields on benchmark 10-year USTs spiked to their highest level in nearly two years. The sudden uptick in yields could be fatal for housing which has rallied on the Fed’s historic low rates and dwindling inventory. Early reports from many of the hotter markets suggest some pullback on sales already although the extent of the damage won’t appear in the data for another month.

Adding to the foofaraw surrounding the Fed’s announcement, the Bank for International Settlements released a report on Monday calling for an end to quantitative easing. The BIS, which is called the bank of the central banks, posits that it’s time for the world’s CBs to end their “extraordinary actions” and “accommodation” and return to downsizing, deleveraging and austerity. Economist Paul Krugman ridiculed the BIS report in a post on his blog on Monday saying:

“Part of what makes the report so awesome is the way that it trots out every discredited argument for austerity, with not a hint of acknowledgement that these arguments have been researched and refuted at length.” (“Dead-enders in Dark Suits”, Paul Krugman, New York Times)

Naturally, the report was full of the expected attacks on labor protections, health care, and pensions, the perennial targets of bankers and the investors class. Here’s a clip from the report:

“By hindering the reallocation of capital and workers across sectors, structural rigidities put the brakes on the economic engine of creative destruction…. Measures to curb future increases in pension and health care spending are key to the success of these efforts.”

In other words, dying under a freeway overpass (no health care) is a small price to pay for bigger profits for rapacious mega-corporations. Where have we heard that before?

In any event, it’s hard to believe that anyone is going to follow the advice of the tone-deaf BIS. In fact, even the IMF has parted ways with the belt-tightening crackpots and called for a repeal of the ill-conceived budget cuts (aka–the “sequester”). Surprisingly, the IMF has said that “deficit reduction in 2013 has been excessively rapid and ill-designed”. Here’s more from the Fund’s statement:

“The automatic spending cuts (“sequester”) not only exert a heavy toll on growth in the short term, but the indiscriminate reductions in education, science, and infrastructure spending could also reduce medium-term potential growth. …. At the same time, the expiration of the payroll tax cut and the increase in high-end marginal tax rates also imply some further drag on economic activity. A slower pace of deficit reduction would help the recovery at a time when monetary policy has limited room to support it further.” (IMF)

Is the IMF really acknowledging that monetary policy (notably: QE) has been a flop? Bernanke’s uber-accommodative easing hasn’t lowered unemployment or boosted inflation. Long-term rates are higher now than they were when the program began 6 months ago! Only stock prices have rebounded. Equities are more than 140 percent higher than their March 2009 lows, mainly due to the Fed’s lamebrain “pedal-to-the-metal” policy which is now causing violent gyrations on stock indices around the world. And let’s not forget the $11.2 trillion US Treasuries market, which–according to Andy Haldane, Director of Financial Stability at the Bank of England, “Is the biggest government bond bubble in history.” (Now, that’s saying something) Haldane added that “a disorderly reversion” in bond yields is the “biggest risk to global financial stability.”

Indeed. The dangers to the financial system and the broader economy are quite real. Even so, stocks will probably not fall of a cliff anytime soon, rather their steady retreat will be preceded by months of erratic rand excruciating rollercoaster swings signaling widespread loss of confidence in the Fed and growing uncertainty about the future. Journalist Adam Shell summed it up best on a Monday piece on USA Today. He said:

“The market is undergoing a real-life reality check that will show just how much of the market’s gains were due to the so-called “sugar rush” caused by the Fed’s QE program, which is currently injecting more than $1 trillion into the financial system annually….No one quite understands what the removal of that amount of liquidity over the next year will do to interest rates or stock prices.” (“Market eyes fresh ‘fix’ as Fed plans QE withdrawal”, Adam Shell, USA Today)

The question is whether the economy “can stand on its own two feet or not”? If it can’t, then we must assume that QE was the wrong policy which, of course, it was.